Further EU support for Irish banks and Ireland’s corporation tax regime have emerged as stumbling blocks in German coalition talks.

In a worrying development for the Government, Germany’s Social Democrats have “flatly rejected” proposals to allow Irish banks directly access money from the euro rescue fund in talks with Angela Merkel’s Christian Democrats.

According to an article in the German daily Sueddeutsche Zeitung, the SDP wants Dr Merkel to withdraw her support for direct bank recapitalisation as a precondition for a coalition.

“Merkel must go to Brussels and withdraw her support for a direct bank recapitalisation by the ESM [bailout fund],” SPD finance spokesman Carsten Schneider told the paper.

The party is insisting that Europe’s banks must instead establish their own fund that could take weak banks under its wing, a policy aimed at protecting German taxpayers from the further costly bank rescues.

Dr Merkel’s most likely coalition partners are also said to be seeking “far-reaching commitments” from Dublin on tax issues in return for loans to the Irish Government.

The party wants a precautionary credit line from the ESM which will facilitate Ireland’s full return to the capital markets at the end of the year tied to an increase in Ireland’s 12.5 per cent corporation tax, and the abandonment of Dublin’s opposition to the proposed financial transaction tax.

While 11 euro zone states plan to move ahead with a common transaction tax, talks have so far faltered on concerns about its legality.

At a summit in June, euro zone finance ministers agreed to consider requests for retroactive ESM recapitalisation on a case-by-case basis.

This was heralded as a breakthrough by Minister for Finance Michael Noonan who has consistently argued that AIB and Bank of Ireland should be eligible for retroactive aid from the ESM, as the instrument was not available to Ireland at the time of the bail-out.

However, the today’s developments create an uncertainty as to whether a new German government will support the already unpopular ESM bailout fund being used in this way.

The Social Democrats supported Dr Merkel’s policy for dealing with the euro crisis during the recent parliamentary session. However, during the election campaign, they distanced themselves from her policies, characterising plans to allow the ESM directly recapitalise distressed banks “as unacceptable”.